Merrill's Latest Embarrassment: Stan O'Neal's Outgoing Compensation

So, now we know. Stan O'Neal, the CEO who presided over $8B+ in losses at Merrill Lynch this year, is officially out.

Some combination of insiders are temporary co-presidents, or co-CEOs, or some such.

But the real news this morning is poor Merrill's board's continuing embarrassment vis a vis O'Neal's outgoing pay package.

Today's Wall Street Journal mentioned a total figure of some $160MM, which was separately mentioned on CNBC this morning, as well. The Journal piece provides detailed breakdown of that amount, citing various retirement benefits, options, and deferred compensation.

It is stated that O'Neal had no contract with the firm, and, thus, receives no formal severance.

By late this afternoon, or perhaps tomorrow morning, we should expect to hear from the corporate governance and executive compensation crowd regarding O'Neal's lush "parting gifts," as he leaves the firm he so recently torpedoed with his aloof, casual "oversight" of Merrill's mortgage-related businesses.

It has to be galling for Merrill's board members to realize that they will be perceived as both a laughing stock, and pernicious in their own right, for allowing Stan O'Neal to retain so much money after nearly ruining the firm of which he was CEO for five years.

I've written on this topic many times before in this blog. You may find those posts by clicking on the labels 'executive compensation,' and/or 'corporate governance,' or by searching the blog on those terms. My personal favorite on this topic, from November of 2005, may be found here.

However, as I watched CNBC report on the two-day long travail at Merrill, while the board ostensibly negotiated with O'Neal on some sort of monetary compromise that would allow the former to appear to be prudent trustees of their shareholders' interests, another idea occurred to me.

Why didn't Merrill's board, and, for that matter, the board of any publicly-held, financial services sector company, require a new CEO to sign an agreement which states performance and event conditions under which the CEO is eligible to lose all but an agreed minimum amount of money if s/he is dismissed from, or resigns, the CEO post?

Honestly, this seems like a pretty obvious clause, now that I see how badly O'Neal damaged Merrill. Think about that.

Here's a guy who presided over, and abetted, the loss of more than $8 BILLION this year, and he still walks with $160MM.

I don't care how that $160MM was earned, or over what time period. The truth is, the nature of financial service firms is such that a CEO, or, as I've written recently, here, any senior executive, can play the 'heads I win, tails you lose' game all too easily by risking the shareholders' equity.

In this regard, financial service companies are a bit different than those in most other sectors. Pumping growth at a financial services firm often leads to simply taking more risk.

In order to help a CEO own the responsibility for not allowing this to happen, why not simply make all deferred CEO compensation over an amount with which the board would not be embarrassed to have a loss-inducing CEO leave, subject to revocation and loss, in the event of certain conditions.

These conditions could include the occurrence of loss, as reported on financial statements, exceeding, either annually or cumulatively, a stated amount. Or perhaps a percentage decline in total return, adjusted for the S&P500 Index.

By making a new CEO aware that extreme losses and failure would not result in loss of the post with substantial financial rewards, such a candidate would probably be more cautious when running the company.

Now, you may ask, would a company like Merrill be able to attract a seasoned, talented executive such as Larry Fink, with such conditions?

Why not? After all, the board should be attracting CEO candidates who genuinely believe in their abilities to improve and sustain shareholder return performance during their tenure. If they aren't willing to bet a substantial portion of their compensation on that, why would you hire them?

In the case of a Larry Fink, Merrill would probably have to pay him for any unvested deferred compensation that he lost when leaving BlackRock, if the had to leave that firm. This money would be Fink's, not subject to the conditioned agreement.

Then, if the board would honestly be fine with letting Fink fail, and preside over spectacular losses, yet still leave with tens of millions of dollars, then they don't need such an agreement.

However, as the Merrill board now understands, being in the moment of such embarrassment is very chastening. You can bet they would pay plenty right now to simply not have the appearance of compensating the guy who just put Merrill's stability in jeopardy, after losing a huge chunk of shareholder value this year.

In a way, think of my idea as a sort of board of directors risk management. It's a tool to provide for capping financial risk and embarrassment at the CEO level. It removes the asymmetry with which most CEOs are allowed to operate- they are paid lushly for success, and pretty well for failure, too.

While still an enormous sum of money to the average American, limiting a failed CEO to, say, just $5MM of any deferred compensation or severance, no matter how it had been 'earned,' would be reasonably palatable for a board to explain. Five or ten million dollars, while a pittance among CEOs, would be sufficient to claim that the board was providing a fair minimum guaranteed final payment to a CEO, even if s/he failed utterly and lost huge sums of shareholder value.

If a CEO candidate could not understand the need for a board to provide this insurance to shareholders against CEO ineptitude, why would a board hire her/him?